Best Sectors to Buy in the Fourth Quarter

The third quarter marked the worst quarter for stocks since 2011. But the fourth quarter is beginning to take a different turn. Will the weakest sectors of Q3 turn south again, or will early Q4 momentum carry through the remainder of the year? What sectors will perform best in Q4?
One of the hardest hit sectors of Q3 was health care, which was dragged down by biotechnology stocks. For example, through the first half of 2015, a top-performing biotechnology mutual fund was the Fidelity Select Biotechnology Portfolio Fund (FBIOX), which jumped over 25% in the first two quarters but fell nearly 20% in the third quarter.
The energy sector was dragged down by falling oil prices as marked by an 18% price drop for the Energy Select Sector SPDR Fund (NYSEArca: XLE), which was actually one of the better performers in the sector.
Another big loser in Q3 were Chinese stocks, which dropped 21.8% as measured by the iShares MSCI China ETF (NYSEArca: MCHI).

Worst Sectors for the Fourth Quarter

Making predictions about the short-term direction of the stock market is challenging, if not futile. However, a prudent path to juicing your portfolio returns over the next three to six months is to add or increase exposure to two or three sectors that show short-term promise. But the process of finding the best sectors starts with eliminating what we believe to be the worst.
Perhaps the biggest question mark still surrounds the timing of a recovery for Chinese stocks and emerging markets in general. The risk outweighs the potential for gain in these areas. So stay away for now.
Energy started Q4 with a 13% price gain, as measured by XLE, but this big gain could prove to be more of a dead cat bounce than a trend. With that said, buying an ETF that invests in high-quality large-cap energy stocks is not a bad idea now as long-term play. Just don’t bet on much more upside for energy in the fourth quarter.

Best Sectors To Buy

Here are three sectors that show promise for the rest of 2015:

• Consumer Discretionary: Despite the downside pressures of China, the Federal Reserve and the commodities slump, the American consumer is still holding up well. The consumer discretionary sector looks to continue its strength through the end of the year. While active investors and media types bury themselves in concerns about economies and capital markets, the U.S. consumer is enjoying an improved employment environment, low interest rates and low gas prices, all of which combine to leave more spending money in their pockets.
• Technology: Unless you believe a bear market has begun and the U.S. economy is about to enter recession, now can be a good time for technology stocks. Growth stocks, including tech stocks, tend to outperform during the late-phase of the business cycle, which is arguably where the U.S. is now. For example, the Powershares QQQ (NASDAQ: QQQ) is up 3.4% year-to-date, whereas the S&P 500 is below zero. If not for the biotech decline in Q3, the growth and tech-laden Nasdaq index would be up even higher. This momentum may very well continue for the rest of 2015 and into 2016.
• Utilities: For investors wanting to buy beaten down shares of dividend-producing value stocks, dipping into the utilities sector can be a good idea now, especially if holding for more than just a few months. Utilities were one of the weakest sectors in the first half of 2015 but it was among the best in Q3 and is up over 6% in just the past month, as measured by the Utilities Select Sector SPDR Fund (NYSEArca: XLU). The weakness in the first half of the year was primarily due to negative pressure on dividend stocks in the face of rising interest rates. Now that a rate hike is likely priced in, investors seem to like the utilities sector again. The sector also has defensive qualities, which may come in handy in an approaching bear market.

Bottom line on buying sectors: Investors are wise to keep allocations to sectors at around 5% each and use them as diversification tools first and as portfolio performance enhancers second.
Kent Thune is the owner of an investment advisory firm in Hilton Head Island, S.C. He personally does not hold any of the aforementioned securities, although he holds XLE and XLU for some client accounts. Under no circumstances does this information represent a recommendation to buy or sell securities.

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